Investment Scenario
Concept of Investment
We can define investment as the process of, 'Sacrificing something now for the prospect of gaining something later'. Our definition implies that there are three dimensions to an investment - time, today's sacrifice and prospective gain.
We can, of course, think of a number of transactions which will qualify as 'investments' as per our definition. Consider, for example, the following transactions:
1. In order to settle down, a young couple buys a house for Rs.3 lakh in Bangalore.
2. A wealthy farmer pays Rs.1 lakh for a piece of land in his village.
3. A cricket fan bets Rs. 100 on the outcome of a test match in England.
4. A government officer buys 'units' of Unit Trust of India worth Rs.10000.
5. A college professor buys, in anticipation of good return, 100 shares of Reliance Industries Ltd. for Rs.40000.
6. A lady clerk deposits Rs.5000 in a Post Office Savings Account.
7. Based on the rumor that it would be a hot issue in the market in no distant future, our friend John invests all his savings in the newly floated share issue of Fraternity Electronics Ltd., a company intending to manufacture audio and video magnetic tapes to start with, and cine sound tapes at a later stage.
A common feature of all these transactions is that something is sacrificed now for the prospects of gaining something later. For example, the wealthy farmer in transaction 2 sacrifices Rs.l lakh now for the prospects of crop income later. The lady clerk in transaction 6 sacrifices Rs.5000 now for the prospect of getting a larger amount later due to interest earned on the savings account. Thus, in a broad sense, all these seven transactions qualify as investment.
Speculation involves buying, holding and selling of stocks, bonds, commodities, etc., to profit from price fluctuations as compared to buying it for use or for income via dividends, interest, etc.,
Another form is Hedging which is a type of investment done to specifically cancel or reduce the risk in another investment. It is a strategy to minimize exposure to an unwanted business risk while still allowing the business to profit from an investment activity.
Another type of trading in stocks, bonds or commodities is Arbitrage. It is the practice of taking advantage of a state of imbalance between two or more markets. A combination of matching deals is struck that capitalize upon the imbalance, the profit being the difference between the market prices.
Are all investments speculative?
We know that investment means sacrificing or committing some money today in anticipation of a financial return later. The investor indulges in a bit of speculation as to how much return he is likely to realize. There is an element of speculation involved in all investment decisions. It does not follow though that all investments are speculative by nature.
Genuine investments are carefully thought out decisions. They involve only calculated risks. The expected return is consistent with the underlying risk of the investment. A genuine investor is risk averse and usually has a long-term perspective in mind. The government officer's investment in the units of UTI (transaction 4), the college professor's Reliance stockholding (transaction 5), and the lady clerk's Post Office Savings Deposit (transaction 6), all may be regarded as genuine investments. Each person seems to have made carefully thought out decision and each has taken only a calculated risk.
Speculative investments on the other hand are not carefully thought out decisions. They are based on rumors, hot tips, inside dopes and often simply on hunches. The risk assumed is disproportionate to the return expected from speculation. The intention is to profit from short-term market fluctuations. In other words, a speculator is relatively less risk averse and has a short-term perspective for investment. Our friend John's decision to invest all his savings in the new issue of Fraternity Electronics based only on the rumors (transaction 7) may be labelled as speculative investment. John does not seem to have carefully thought out this decision. He is taking a high risk by putting all his savings in just one stock and that too in a new stock.
So, an investment can be distinguished from speculation by (a) the time horizon of the investor and (b) the risk-return characteristics of the investments. A genuine investor is interested in a good rate of return, earned on a rather consistent
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